Global Credit Research Credit Opinion 7 NOV Credit Opinion: BT Group Plc. BT Group Plc. United Kingdom. Ratings. Esat Telecom Group plc

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1 Global Credit Research Credit Opinion 7 NOV 2008 Credit Opinion: BT Group Plc BT Group Plc United Kingdom Ratings Category Moody's Rating Esat Telecom Group plc Issuer Rating British Telecommunications Plc Issuer Rating Senior Unsecured Commercial Paper P-2 British Telecom Finance, Inc. Bkd Senior Unsecured British Telecom Finance B.V. Bkd Issuer Rating Bkd Commercial Paper P-2 Contacts Analyst Phone Paloma San Valentin/Madrid Carlos Winzer/Madrid David G. Staples/London Key Indicators [1] BT Group Plc Financial Metrics Fiscal Year ending: 31/03/ /03/ /03/2008 EBITDA Margin % 30.7% 29.4% 29.5% RCF / Net Debt 25.0% 32.3% 30.7% FCF / Net Debt 4.1% 1.2% 4.6% Debt / EBITDA 3.0x 2.4x 2.6x (FFO + Interest Expense) / Interest Expense 5.0x 7.1x 6.7x (EBITDA-CAPEX) / Interest Expense 2.3x 2.7x 2.6x [1] Financial metrics as adjusted by Moody's Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Opinion Corporate Profile BT Group Plc ("BT", the Group), which operates principally through its 100%-owned subsidiary British Telecommunications plc (rated, negative outlook) is the leading provider of local, long-distance and international telecommunications services in the UK. As at 30 June 2008, BT controlled approximately 22.1 million retail access lines (23.6 million at end-june 2007), including 4.5 million broadband connections (3.8 million at end-

2 June 2007). Wholesale broadband connections were 8.3 million, down from 8.8 million a year earlier. Following the settlement reached with Ofcom, the UK regulator, in January 2006 BT transferred its local access network (the local loop), along with its management and associated services into a discrete, regulated entity. This division, called Openreach, delivers local access services both to other BT divisions and to competing telecom service providers on an equivalent basis across the UK through its two primary products: wholesale line rental (WLR) and local loop unbundling (LLU). In addition the Group operates through three other divisions: BT Retail, which provides fixed-line voice and data services to end-residential and business customers nationwide; BT Wholesale, which sells fixed-network services to all communications operators interconnecting with BT's fixed UK network; and BT Global Services, which provides managed telecoms and IT services and consultancy to multi-site organisations worldwide. BT Wholesale and Openreach generate the majority of group operating cash flow - approximately 57% of FYE 31 March 2008 (2007/8) company-reported EBITDA of GBP5.9 billion (before specific items and leaver costs) - and are also the most capital-intensive operations reflecting their ownership of the national and local infrastructure assets. BT also manages its businesses by distinguishing between the traditional retail and wholesale operations of its traditional fixed networks, which it is defending from regulatory and competitive pressure, and the new wave operations it is growing to offset declining traditional revenues. New wave, which includes Networked IT, Broadband and Mobility services, generated 39% of Group 2007/2008 revenues of 20.7 billion, up from around 25% three years ago. Rating Rationale The rating reflects that like its major European incumbent peers, BT is adapting to an environment where market shares and margins on traditional fixed-line voice telephony services are facing increasing competition and regulation. Unlike its peers, however, the Group does not benefit from revenue growth and profitability of a substantial wireless operation. BT's business model is therefore undergoing a significant transformation, following a consistent strategy, and manifest in certain trends including a progressive shift in turnover mix from retail to wholesale, and from traditional to new wave revenues. The rating takes account of the potential risks in BT's transformational strategy, and recognises that it has executed this quite well so far under the new organisational structure which came into effect in October 2007: Moody's expects management to successfully address recent signs of underperformance at BT Global Services, which have become an increasing source of concern. Revenues lost as a result of declining traditional market share have effectively been substituted with growing new wave revenues so that Group quarterly revenues have shown steady growth in recent periods. Although these are currently lower margin, in Moody's view there are grounds for margin improvement in the medium-term stemming from rationalisation of networks and standardisation of product/service solutions. Moody's Rating Methodology for the global telecoms industry considers the factors most relevant to telecoms operators, sets out the range of possible outcomes by factor and maps these to a rating range. It also demonstrates how each factor, as part of an aggregate, contributes to the rating output of the methodology. The telecom methodology outcome for BT is Baa2, and is summarised in the grid below based on the 2007/8 financial statements. The difference between the Baa2 methodology output and BT's assigned rating of, takes account of the Group's scale, as well as management's successful execution so far of its transformational strategy. Measurements are quantitative where we can define an appropriate metric. However, for some sub-factors, qualitative judgment or empirical observation is necessary to determine the appropriate category. Of the 13 subfactors, four are qualitative and nine are quantitative. However, it is important to note that two of the qualitative sub-factors (business model and competitive environment, and technology risk) articulate quantitative measures that guide the ultimate qualitative assessment. The qualitative factors mostly reflect the benefits associated with the company's status as a fixed-line incumbent. As a general point, in common with its peers, we would not expect any significant migration in BT's qualitative factors over the rating horizon; any medium-term change in the rating outcomes under the model is thus more likely to result from changes in the quantitative metrics. Two of the four qualitative sub-factors rank in the single-a category, reflecting for the most part the benefits associated with its status as fixed-line incumbent. The two Baa-rated qualitative factors reflect the impact of BT's limited diversification and management's balanced financial strategy. The table below shows that, of the quantitative factors (calculated on the basis of 2007/8 financials), one ranks in the Aa category (Total Revenues) and another one (Market Share) on the Baa category, reflecting the impact of deregulation and competition on BT's market position. However, the Baa2 model outcome is significantly affected by the outlying quantitative financial inputs - a very low free cash flow/adjusted debt ratio of 4.6%, which positions it within the B range; and low EBITDA margin and trend, as well as (EBITDA-Capex)/Gross interest expense coverage ratio, which position it within the Ba range. Factor 1 (a) `Size and Scale' (Aa): A key determinant of the credit quality of a company is its size and total annual revenues. Specifically, larger companies are more broadly diversified, which can reduce volatility and provide the flexibility to generate cash from the divestiture of certain operations, if needed. Larger companies also benefit from greater financial resources and economies of scale. At GBP20.7 billion in 2007/8 revenue, exceeding US$40 billion-equivalent, Moody's ranks BT in the Aa category. Factor 1 (b) `Business Model and Competitive Environment' (Baa): Moody's views an integrated telecoms business model as more robust than either a standalone fixed-line operation or a wireless business because of the ongoing

3 pace of technological change. As a strong wireline incumbent with a large and stable business, BT's model is ranked Baa. Moody's recognises BT's commitment to growing beyond fixed line, and considers that its networked IT services business and mobility revenues help diversify BT's business risk profile. However, in Moody's view, BT's lack of a strong mobile arm is a disadvantage in comparison with most of its European incumbent peers, which have a greater opportunity for developing a convergence offer and can in the meantime benefit from developing growth trends in either or both segments, as well as hedging their exposure to slowing sub-segments (such as fixed voice). Moody's considers the competitive environment for a particular telecoms market by looking at the industry structure and number of players. Moody's acknowledges that competition in BT's key markets is intensifying. For example, the market in provision of local access, including broadband, has seen a sharp increase of providers and capital employed as LLU has accelerated over the past few years. Competition in fixed-line voice has also increased through the pick-up in wholesale line rental (WLR) arrangements, whose pricing has become more attractive to alternative service providers. The outlook is for BT's fixed-line share to continue to erode, with WLR arrangements expected to compound the share already lost to carrier pre-selection. BT's Baa ranking in this category balances the outlook for negative growth in the Group's traditional fixed-line voice markets (-1.5% growth in traditional segment reported in 2007/08, which favourably compares with -3% in the previous year, reflecting success in BT's defensive strategy in this segment) against the better prospects for its broadband and networked IT services businesses (9.1% growth in new wave reported in 2007/08). In common with other European incumbents, BT's retail fixed-line voice operations continue to be pressured by ongoing structural substitution by mobile voice, texting and , and more generally by the shift away from traditional public switched telephone network (PSTN) delivery towards IP-based services. Shrinking traditional voice markets are offset by better growth prospects in both: (i) the UK DSL broadband market, which continues to grow although at a decreasing rate as penetration rises (BT reported revenue growth of 10% in Broadband & LLU for 2007/8, with 18% growth in total DSL and LLU broadband connections); and (ii) the global market for networked IT services, which BT has estimated should be around 500 billion by 2008/9, a rise of more than 40% over three years. Steady increase of revenues and order book in recent periods support an outlook for growth which, when combined with broadband, helps partly offset erosion of traditional revenues in line with BT's strategy. Factor 2 (a) `Regulatory and Political Framework' (A): In common with elsewhere in Europe, the UK regulator Ofcom continues to actively promote choice for users and competition among providers of telecoms services. In broad terms, Ofcom's approach is to promote competition through regulation at the wholesale access level, rather than micro-management of access and prices at the retail level. The relative clarity of the wholesale-focused regulatory approach adopted in the UK appears to benefit both BT and the telecoms market in general, by reducing the levels of complexity in strategic and operational decision-making. On balance, therefore, Moody's considers an A ranking appropriate for the checks and balances represented by the regulatory framework in the UK. Factor 2 (b) `Technology Risk' (A): Moody's ratings take account of a company's exposure to technological advancement and how well-positioned it may be in handling such developments. Factored in are the potential capital expenditure (capex) implications of any technological improvements and advances. In this regard, BT's ratio of capex to revenues was reported at 16% during FYE March 2008, which represents an A ranking for this factor under Moody's methodology. The A rating assigned in this category also reflects Moody's view that technology risks are mitigated by BT's transformation strategy - including the defence of traditional revenues, combined with growth of substitutive new wave businesses and BT's investment in 21CN, its next generation IP network. This assessment also includes BT's latest announcement on fibre-optic broadband network rollout over the next five years, which will allow it to better address customer needs with improved services and which will be dependant on achieving a supportive regulatory framework, as described in more detail in Recent Events below. Factor 2 (c) `Market Share' (Baa): The relative positioning of a telecoms operator within its market segments is important to its rating outcome as it is indicative of the likely sustainability of its operating position and ability to exercise control over the nature and pace of development in the industry. Moody's assigns a Baa rating in this category, representing market shares which, on average, are in the range of > 35%-45%. Although the Group has very strong shares in its traditional domestic fixed markets, these are steadily declining under the impact of deregulation and technology. Moody's considers them to be offset by its lower (though still strong) shares in retail broadband and networked IT services. Despite ongoing share attrition, as the incumbent, BT remains by some distance the UK's leading wireline operator. As of end December 2007, BT had a 62.8% share of fixed revenues in the domestic market, down from 71.1% four years earlier. BT's market share in fixed voice is expected to continue to face pressure from the competition promoted by the UK's regulatory framework, whether from other network operators, like cable, or service providers reselling access provided by BT on a wholesale basis. Moody's considers that significant risks are implied for BT and its competitors by the large amount of capital invested by the growing number of existing operators and entrants into the UK broadband market. Critical to BT's maintenance of its position will be the extent to which its value-added service-based strategy succeeds in winning share from what have so far been mainly price-based competitive offerings.

4 In broadband, the company estimates it has 35% retail broadband market share (including DSL and LLU installed base). Although on the low side in comparison with its European peers, BT's share has been relatively stable as the market has grown, although Moody's considers the current rapid growth of LLU to be a potential risk to BT's position. With regard to networked IT services, BT's competitive advantage lies in its unusual ability to deliver unrivalled network capacity and the consultancy and advisory expertise to make the most of it. By contrast, many of its competitors in the market are able to deliver either network capacity or IT consultancy services - but seldom both. Nevertheless, the fragmented nature of the market and relatively low barriers to entry in individual geographical regions result in a large number of competitors which, even if few have the scale of BT, constrains the margins achievable in this segment. Factor 3: `Management's Financial Strategy' (Baa): Management's strategy and tolerance for financial risk will directly affect debt levels and credit quality, and is therefore a key rating determinant. BT scores Baa in this factor in light of the company's financial policy being balanced between stockholders and creditors; potential for rating migration following (debt-financed) acquisitions; and a public commitment to metrics that are consistent with an investment-grade rating. In this regard, BT's suspension in July 2008 of its GBP2.5 billion share buyback to May 2009 (GBP1.8 billion actually returned to shareholders) in support of an incremental GBP1 billion in enhanced broadband roll-out investment (see Recent Events), illustrates a prudent approach to financial policy and BT's intention to preserve its financial strength following strategic decisions. Factor 4: `Operating Performance' (Ba): The level and stability of operating margins is a key consideration in assessing risk to debt holders. When considering the scores for this factor, Moody's reviews the EBITDA margin trend, as well as the absolute level of EBITDA. The trend in EBITDA margin measures the direction of earnings (stable, improving or declining) and it is a leading indicator of the company's business trajectory. BT scores Ba in this factor, based on the 29.5% adjusted EBITDA margin and the relatively stable EBITDA trend over the past two years. BT is facing significant challenges as it struggles to grow in a market affected by strong price pressure, regulatory constraints and line and usage deterioration (fixed to mobile), but its transformational strategy is aimed at mitigating the extent of a negative impact on the Group's profitability. In particular, cost efficiency initiatives (`right first time', e-bills, procurement and sourcing, streamlining the number of systems and processes under the 21CN platform, etc.), have resulted in GBP625million in savings in FYE 2008 and BT targets GBP800million in FYE As reported by the company, these initiatives are coupled with a focus on speed to market and enhancement of the customer experience. Factor 5: `Financial Strength' (Ba): BT's revenue for the fiscal year ended 31 March 2008 grew by 2.4% year on year to GBP20.7 billion, while reported EBITDA increased by 2.3% to GBP5.9 billion (before specific items and leaver costs). Revenue and profitability trends continue to reflect BT's transformational diversification strategy underpinning modest low-single-digit growth and EBITDA margin contention, although still under pressure from market dynamics. The strategic investment required has also translated in rising on-balance-sheet debt levels (from GBP14.5 billion to GBP15.8 billion in 2007/08): at 2.6x, gross debt/ebitda as adjusted by Moody's is, however, well positioned towards the mid-point of the 2x-3x range. For 2007/8, the two key cash flow metrics used by Moody's - retained cash flow (RCF)/net debt of 31% and free cash flow (FCF)/net debt of 4.6% are placed at the mid-point of their respective ranges for the Baa and B categories in Moody's model (25%-35% and 2%-6%, respectively). At 6.7x and 2.6x, both coverage ratios were also comfortably positioned within their Baa and Ba categories (5x-7x and 2x-3.5x, respectively). Looking forward, Moody's expects BT's reported annual funds from operations (FFO) to remain at around GBP4.5 billion p.a., although some further weakening of credit metrics within existing bands could occur. RCF is anticipated to be in the region of GBP3.5 billion p.a. over the next couple of years, but FCF generation (before share buybacks) will be impacted by the incremental NGN cap ex effort. Any operating performance shortfalls translating into lower CF generation will put further pressure on these measures. In addition, Moody's further expects that the company will be focused on current markets and with limited acquisitions, and that the capex-to-sales ratio will remain around current levels in the medium term. Liquidity Profile BT's liquidity profile, supported by cash flow generation, existing cash and marketable securities balances of GBP1.3 billion as of end-june 08 and unutilised committed lines of credit amounting to GBP2.4 billion, is more than sufficient to cover its remaining debt maturities and other cash demands, including capex and dividend payments. Over the next 12 months, Moody's expects BT to generate more than GBP4.5 billion of funds from operations (after tax and interest payments). The main uses of such cash include dividends of around GBP1.2 billion and capex of roughly GBP3.2 billion, as well as debt repayments of around GBP1.3 billion as of end-june 08 and a share buyback programme of GBP300 million (the remainder was cancelled after the fibre roll-out announcement). External liquidity sources are adequate, with a committed borrowing facility of GBP1.5 billion up to January 2013 to support its commercial paper (CP) programme, and additional undrawn committed borrowing facilities of GBP900 million maturing in March 2009 with one year term-out at BT's option and GBP10 million shortterm maturing in January The bank facilities do not contain a repeating MAC clause or financial covenants. Recent Developments

5 BT's rating was left unchanged following the announcement in May 2007 that it intended to return GBP2.5 billion to shareholders in the two years to March 2009, reflecting Moody's view that on the basis of current assumptions on the outlook for operating performance, capital expenditure and acquisition policy, the group had the financial flexibility to make the distribution and maintain credit metrics aligned with the rating category. On 15 July 2008, BT announced a GBP1.5 billion programme to roll out fibre-based, super-fast broadband to as many as 10 million homes by 2012, in the context of BT's wider strategy of delivering next generation network (NGN) services nationwide to support revenue growth in the future and in line with what other incumbent operators are doing elsewhere. Around GBP1 billion is incremental to BT's existing expenditure plans over the next five years. Given the strategic priority of this plan and BT's intention to preserve its financial strength, the board decided to suspend the current share buyback programme with effect from 31 July By this date, BT had returned in excess of GBP1.8 billion of the planned GBP2.5 billion buyback programme. Moody's noted that although the capex programme is substantial, it will be gradually deployed over time and it does not materially erode the group's debt protection ratios, thus being ratings neutral. In addition, Moody's noted that the increase in capex was offset by the suspension in the share buyback programme and therefore only represents a redeployment of existing discretionary cash flow from shareholder remuneration toward investment. In Moody's view, BT retains sufficient financial flexibility to accommodate this investment and to maintain credit metrics aligned with the existing rating given the accompanying changes to its shareholder remuneration plans. The rating also assumes BT will continue with its transformational strategy, and its focus on organic rather than acquired growth. Any potential acquisitions are expected to be bolt-on in scale, and financed largely from free cash flow. Rating On 4 November 2008, Moody's affirmed the senior unsecured and P-2 ratings of BT Group Plc and related rated issuers but changed the outlook to negative from stable. The change in outlook reflects Moody's concerns regarding BT's recent announcement with its revised guidance that margins and operating performance trends at its Global Services unit will be weaker than had originally been factored into the rating. Of particular concern will be the impact, if not addressed successfully by the proposed cost cutting measures and management changes, on BT's overall cash flow generation capacity. Moody's rating is underpinned in part by the expectation that the company will be successful in executing on its growth strategy on the Global Services side which has included the assumption of both revenue and margin expansion in order to offset expected weaker performance by the more traditional fixed-line telecom segments in conjunction with maintaining tight cost controls. Failure to achieve substantial efficiency savings in BT Global Services coupled with performance decline in the other divisions, particularly as we enter a more difficult economic environment, could put further pressure on the rating. In particular, operating performance shortfalls could result in weakened cash flow measures such that RCF to net debt and FCF to net debt are no longer consistent with the rating category. The current rating has assumed that adjusted RCF/Net Debt will be at least 25% and that the company would be generating solid and sustainable FCF metrics. Financial flexibility remains also constrained by potential volatility arising from pension deficit movements on a pension asset base of GBP36.8 billion at end-june BT's flexibility at the rating level is now limited as a result of all these considerations, reflecting the challenges it still faces in maintaining its position in broadband and growing profitability in networked IT services. pressure on the rating could further develop if there were adverse variances from current expectations, whether in terms of strategy, operating performance, or potential material acquisitions or investment. What Could Change the Rating - Up Key factors that could result in an upgrade include: Settled and improving business risk profile underpinned by sustainable delivery on BT's new wave business, resulting in a growing revenue base Moderated shareholder remuneration policy, re-allocating cash to debt reduction Sustainable growth in cash flow after regular dividends and capital expenditure such that RCF to adjusted net debt exceeds 30% and FCF to adjusted net debt reaches 15% What Could Change the Rating - Down Key factors that could result in a downgrade include:

6 Revenue, profitability and cash flow growth provided by new wave businesses fails to more than offset decline in traditional business Cash flow measures weaken whether through operating performance shortfalls, or increases in debt such that: (i) RCF to adjusted net debt declines towards the low 20s%; and (ii) the company fails to show progress in generating solid and sustainable FCF metrics Rating Factors BT Group Plc Key rating factors Aaa Aa A Baa Ba B Caa Factor 1: Size, Scale and Business Model a) Size and scale X b) Business model and Competitive Environment X Factor 2: Operating Environment a) Regulatory and Political X b) Technology Risk X c) Market Share X Factor 3: Strategy and Financial Policies a) Management's Financial Strategy X Factor 4: Operating Performance a) EBITDA Margin X b) EBITDA Trends X Factor 5: Financial Strength [1] a) Total Debt / EBITDA 2.6x b) RCF / Adjusted Net Debt 30.7% c) FCF / Adjusted Net Debt 4.6% d) (FFO + Interest Expense) / Gross Interest Expense 6.7x e) (EBITDA - Capex) / Gross Interest Expense 2.6x Rating: a) Indicated Rating from Methodology Baa2 b) Actual Rating Assigned [1] Financial metrics as adjusted by Moody's Copyright 2008, Moody's Investors Service, Inc. and/or its licensors including Moody's Assurance Company, Inc. (together, "MOODY'S"). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided "as is" without warranty of any kind and MOODY'S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY'S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY'S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY'S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY'S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY'S have, prior to assignment of any rating, agreed to pay to MOODY'S for

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